The PBoC kicked off the first
week of the year by a broad-based RRR cut of 100bp, 50bp of which will become
effective on January 15, while the rest will be executed on January 25. The
announcement was posted on the Central Bank’s website shortly after market close
today, following Premier Li Keqiang’s remarks earlier in the day indicating that
a “broad-based RRR cuts” is on the way. Although this is the sixth RRR cut in
this round, it is the first time it was announced without the prefix of
“targeted” (cut) since February 2016. Prior to today’s announcement, the central
bank has conducted targeted RRR cut on September 30, 2017, the Contingent RRR
Arrangement (CRA) over the Lunar New Year of 2018, “targeted” RRR cut partially
to replace maturing MLF announced in April 2018, the RRR reduction to facilitate
debt-to-equity swap and SME loan issuance in late-June, and the “targeted” RRR
cut to boost inclusive financing and replace MLF. By the end of January 2019,
the RRR ratio would have been reduced by a total of 4-5ppt (depending on the
bank) since 2018.

According to the Central Bank’s
press release, “net” liquidity release from this RRR cut will amount to Rmb
800bn. Although there is still considerable flexibility in monetary policy
conduct which may add to or subtract from the actual amount of liquidity
release, the gesture points to a more accommodative stance of the PBoC. The
central bank also stated that all the maturing MLF in 1Q will no longer be
rolled over, which actually amounts to Rmb 1.2 trillion. However, since we
estimate that a broad-based RRR cut will release ~Rmb 1.5 trillion of liquidity
in total, it is likely for the PBoC to inject liquidity via other forms of
relending in 1Q, including the newly introduced TMLF. However, it is worth
noting that the outstanding MLF stock has grown by a cumulative Rmb 900bn since
the PBoC started to conduct RRR-MLF swap in April 2018. By contrast, the
combined amount of MLF swapped/replaced from the cuts in April & October
2018 should have amount to Rmb 1.35 trillion. This simple analysis highlights
the flexibility of monetary conduct where the actual amount of liquidity
injection may vary from the announced number, nevertheless, a broad-based RRR
cut announced less than 3 months since the last one still points to a more
accommodative monetary policy stance.

The RRR cut aims to provide
liquidity support for the real economy as both domestic and external demand
growth has deteriorated rapidly. In addition, the RRR cut also serves to
(partially) bridge the liquidity gap ahead of the Lunar New Year (LNY) long
holiday. China’s manufacturing PMI dipped below the 50 inflection point in
December and printed the lowest level since March 2016 at 49.4%. Domestic demand
growth has been decelerating visibly on multiple fronts, including discretionary
consumption, property demand and investment, as well as mfg. capex. In addition,
external demand growth has been falling quickly, driven by the double whammy of
a downturn in global industrial cycle, and the “withdrawal symptom” from the
“front-loading” effect before additional US tariff on China exports took effect.
Meanwhile, there is typically a >1 trillion Rmb liquidity gap before the LNY,
which was quoted as one of the reasons behind the timing of the RRR
cut.

Looking forward, we expect
100-200bp more RRR cuts throughout the course of 2019, and downward adjustments
of the open market operation (OMO) rates. In addition, we do not rule out the
possibility of another Contingent RRR arrangement (CRA) ahead of LNY in spite of
this cut. We reiterate that against the backdrop of falling credit demand,
tightened financial regulations, and daunting fiscal funding gap, the PBoC will
likely continue cutting RRR, and potentially lower OMO to facilitate a large
amount of government bond issuance this year. In addition, with corporate
investment returns falling and inflationary impulse receding, effective lending
rate and risk free rate will also likely decline. However, given the
still-restrictive demand-side policies and regulatory environment, we will gauge
the effectiveness of these liquidity injections by monitoring the sequential
growth of adjusted TSF. In our view, the transmission of monetary policy
loosening will likely remain impaired without prompt adjustments to policies
that are choking property demand, local government financing, and the credit
cycle expansion. In our view, the most comprehensive indicator to assess the
effectiveness of the growth stabilization efforts is still adjusted TSF growth –
a notable and sustained pick up in adjusted TSF growth points to potential
recovery of aggregate demand growth.